The world famous George Soros warned a few days ago that a Brexit would spill disaster not only in the short term but send the UK into a recession (here the article).

Who am I to say who is right or wrong?

However, so far, the Pound Sterling plunge already 9.4% against the US$, not so far from Soros’s prediction of a 20% slump. Possibility, next week we will witness a falling Pound Sterling to new low levels. I would like to note that a 9.4% drop for a currency is huge.

Just to put in perspective, the Black Wednesday (the most brutal attack to the Sterling) so the Sterling Pound drop 4.1%.

I’m wondering if Soros is going to make a killing with the Brexit, soon we’ll find it out. At the moment, we’ll focus on opportunities to invest for the long term (we aren’t Soros).

I’m basing this article on facts and hypothesis to determine the possible outcomes of the Brexit on the financial market. Only then we’ll be able to take advantage of new investment opportunities.

WHY BREXIT IS AN OPPORTUNITY

What makes the Brexit an excellent opportunity isn’t the decision itself by getting out of Europe, but instead the fact that the world markets were caught by surprise.

As a result, virtually every negative market shock in history has been a buying opportunity, and this one will be no exception.

Last Friday we already witness a panic with the British Sterling suffering its largest single-day loss in modern history. It isn’t the end.

In the majority of cases, whenever a market or trade end up so badly on a Friday, the following Monday is a catastrophe (could be a black swan if the central banks don’t step in the morning with some reassuring news).

I can expect the Pound Sterling to deep much lower.

Investors are panic-selling because they don’t know what’s going to happen next.

Nothing is better than panic to send share prices and Pound Sterling lower.

Fundamentally, I don’t see much of difference in the UK economy after going back to independence. Sure, they will renegotiate terms and conditions with partners, and they will save some EU partnership fees, but it isn’t going to impact the British multinationals.

Most of the biggest companies trading in the FTSE 100 are international conglomerate making most of their profit abroad. A lower Pound Sterling should only benefit.

Before discussing the investment available, let’s understand the consequences of the Brexit.

BREXIT CONSEQUENCES; DON’T PANIC YET!

First, isn’t going to happen overnight. The exit is a long process and technically will take two years to complete.

The negotiation would revolve around the trade relationship between UK and Europe.

If they follow Switzerland, a series of mutually dependent bilateral agreements that effectively mirror the EU treaties, but give at least the feeling of sovereignty.

The divorce between EU and UK might end up badly. European leaders might respond with hard exit terms to deter other member states from following suit. In the short, UK could be pushed into a recession by their biggest trading partner, EU.

Some international companies – chiefly banks – have voiced that they will be forced to cut thousands of U.K.-based employees, which would be a particularly large blow to London, given its position as the financial epicenter of the U.K. and Europe as a whole.

What about Europe?

The EU project risks disintegrating. If not total fail, the number of members could be reduced to the original 7 strongest one who shares similar economy and GDP.

People dissatisfaction with the European project is mainly focus on:

~ the strongest economies pump money forward the weakest one, which in my opinion will never be able to give it back. Greece is an example.

~ free movement of people has upset European population with an influx of immigrant from Africa and the Middle East who has different values and a poor education.

Will the UK shut down the borders? Difficult to say. The UK need low wage labor to sustain their economy, and closing the immigrant flux will not help local companies.

BREXIT; FACTS & OPPORTUNITIES

Fact 1

The pound plunged to its lowest level in more than three decades immediately after the vote. 9% was the biggest one-day drop in history.

Opportunities

The Pound is a world currency, reliable and with a long history. The Pound is the third most widely held reserve currency with 4% of the world currencies reserve. Investing in a weakening currency is a no brainier for the long term investors.

What are the probability the Pound collapse or go further down?

This chart shows the Pound against the US Dollar for the last 63 years. You will notice the constant decline of the Pound Sterling after the 2WW, however a deeper researched has shown the decline started after the 1WW.

By the chart, look like the Pound Sterling isn’t a good currency to hold for the long term. I still remember when I lost some of my savings back in 2010 when the British Pound went from US$2 to 1.41US$.

Now I’ve got a better understand that the Pound has a long history of proud (as the British people). Britain over the years continued to prop up their currency against a market that clearly wished it to be lower. Even the IMF intervene to rescue the Pound in few occasions and persistence control were necessary to ensure stability.

1979 was a turning point for the British Pound. Exchange controls were lifted, and for the first time, it was allowed to float. And it promptly fell. At the same time, the Us Dollar rose against major world currencies till 1985. The result was a historic low of 1.04 US$ for one Pound Sterling.

So, the closer the Pound Sterling get there this time around, the better chances investors have to profit. Back then the correction was harsh, but in the successive years, the Pound Sterling got back some of the ground.

I consider the Pound Sterling not a great currency to hold for the long-term investors, but a profitable vehicle for the short and medium term in conjunction with investments in stock.

Fact 2

According to Bank of America Merrill Lynch, investors pulled more than $1 billion from U.K. equity funds in just one week leading up to the vote, marking the second-largest weekly outflow for the U.K. in the past 10 years. Last Friday and next week will be a massive flow out of money, leaving on the table great opportunities to get in.

Companies with a U.K. focus have been hit far harder this year than their international counterparts. The FTSE 100, which tracks the U.K.’s largest listed stocks, is down 4.68% year-to-date. The FTSE Local UK, which only includes companies which make at least 70% of their revenues in Britain, is down 12.08%.

Opportunities

The FTSE 100 index is going to fall, the further the better. I’m expecting to see a drop of more than 10% and I would hope for a 15%. But investing isn’t for hoppers and wizards, I just follow the trend.

In the short term, all the sectors will be bitten hard with financial and discretionary stock hit hardest and staples and health-care share outperforming.

There are two possible scenarios here.

The Bank of England reigniting its quantitative easing pushing up the market stock or taking a side position, letting the market mechanism to take the course. This will be seen next week.

BEST UK ETFs

This Fund seeks to track the performance of the FTSE 100 Index, a widely recognized UK benchmark of the UK market’s most highly capitalized blue chip companies.

It’s one of the world’s most international markets, with around 70pc of the profits of FTSE 100 members coming from outside the UK.

The depreciation of the Pound Sterling would benefit the profitability of these companies.

The index is based in Ireland, so there is only 15% Dividend tax.

The P/E is high at 17% but always better than 22% from the similar US index funds. This fund invests in UK large caps with solid history and returns. The yield is exceptional at 4.37%, I know you love this if you are a dividend investors.

The Total asset is 2.7 billion, more than enough to keep this investment liquid as water. The cost a mere 0.07% per year (Vanguard knows how to make it cheap).

The only issue I’ve with this ETF is the large holding in Financial Services.

UK moving away from Europe is going to face financial institutions relocating their operations and staff to Euro zone hubs in the coming years, the City of London (and London’s housing market) will not be spared the pain.

Glencore engages in the production, processing, refinement, transport, storage, marketing, and supply of commodities worldwide. Not only that, they’ve interests in the energy sector. The share priced drop 7% last Friday.

AstraZeneca PLC (AZN.L)

I’m positive on pharma companies and AstraZeneca is one of the giant in the world. Constant revenue, profit climbing, timely dividends are just few of the strength of this stock.

WHAT INVESTMENTS TO AVOID AFTER BREXIT

The majority of local investors will suffer, but international savviest investors will benefit.

Domestic banking and retail share will fall sharply, while staples (tobacco and beverages) and pharmaceuticals should benefit – at least in relative terms – from weaker Sterling as well as their naturally defensive earnings base.

Avoid the small caps, like the FTSE 250 which will experience a large drop-off. Most companies here rely on the local economy to prosper, but with the Brexit, the British population will luckily cutting on spending and investments till a clearer economic picture.

Stay away from bonds, foreign investors might panic at first, initiating a run on U.K. government bonds or gilts. If you are into bonds, US Treasury and US corporate bonds are the best place to be this year and most probably next.

Europe isn’t immune to this situation. The Italian “Borsa” lost 12% of its value on Friday, showing how fragile is the state of the most indebted countries in Europe (Italy, Spain, Greece and Portugal). The Brexit is sending waves through Europe so avoid any markets there including the Euro bonds.

It’s important to be selective when investing in the UK during this time of uncertainty and don’t rush in without some deep analysis. Time will uncover wonderful opportunities, especially if the Pound Sterling will fall further.

CONCLUSION

The Brexit is ramification through the financial system and might trigger a world recession if other factors would step in such a default of China or an unforeseen event.

This situation will benefit the most US as its the only country in the world increasing interest rates. Investors might flee UK and Euro zone bond markets for safer US Treasury bonds.

Europe and UK central banks will inject cash into the system, they might even restart a QE or expand on it.

Gold is an asset to keep at the moment, at least a 10% of any portfolio to hedge against this global fragile financial world.

For myself, the only investment that suit best my needs is the Vanguard FTSE 100 ETF (VUKE.L). The reason I’m going to invest shares here is the convenience to have access to the top International British companies in low-cost fashion and expose myself to the Pound Sterling.

Readers, Are you buying the dip? What are the best investments post-Brexit? What are you doing to take advantage of this chaos?

Brexit; Explore New Investment Opportunities was last modified: April 22nd, 2017 by Rudy

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14 comments

My best compliments for the blog! I’d love to see the list of your holdings, but it seems that it’s not available to check. 😛

I am amazed at your history, the work that you did and the decision to retire, I really look up to you for that…

Regarding Brexit, my take is that it will take a while for the pound to loose more value, mostly because right now NOTHING HAS HAPPENED in real practical terms. Some investors are selling the news, but no real impact has happened because for at least 2 years (but it seems that it’s going to be longer than that) UK will not quit the union. Only then the economic effects will be valued and assessed. What we are seeing today is a massive sell of companies that have business mostly in the UK, everyone is expecting an increased inflation and a further crisis to hit the country.

In reality, right now, the situation is really messy, and this means that volatility is going to be in place for some time.

I am sitting on the sidelines at the moment, might make some movements, but I want to understand better what the UK is going to do, so far we know that Cameron is not going to tell the EU that England wants out, he’ll leave this burden to the next PM…

It’s going to be a hard time, but as you correctly put it, there are a lot of opportunities to reap… Ciao ciao

I really appreciate your view and thank you to share your thoughts on Brexit.

I agree with you that in practical terms nothing is happened, its just a news that is creating chaos because investors, politicians and people can’t figure out the consequences in real terms.

In my investment strategies I focus on numbers and fundamentals, it’s the only winning game when investing in corrections.

Four months ago I invested in mining companies for a simple reason; the cycle in this sector too a turn and the risk of a down trend minimal.

In the case of Brexit, I see a devalue Pound and looking for excellent undervalue UK companies with great products and brands. Whatever EU, UK or politicians will do, doesn’t matter for the underline business with strong fundamentals.

Your idea about publish my holdings is excellent, I’ll get it done as soon as possible.

Great article Rudy! I’m sharing this. I’ve been thinking the same and actually made a small investment on Friday in UK stocks. It very well could drop a bit this week – but I agree, that will just leave opportunity for more. Honestly, the EU still needs the UK, and the U.K. does so much international business (as you mentioned), that I find it hard to see an actual recession without something else happening as well. But only time will tell!

I think UK voters will realize this exit is bad for their country and overturn the vote. But in the meantime, I’d avoid financial stocks and lean more toward consumer staples. One slight correction, BHP is an Australian company, not a UK company. As for Astra Zeneca. I agree that it’s entering the buy zone, but as a dividend investor, I’ll avoid this stock because dividend increases the past few years have been very low. Tobacco, Alcohol, consumer staples is where I’m putting my money. In the alcohol space DEO is looking attractive right now.

Hi Rudy, very good post! I appreciate the thorough analysis of Brexit as well as the possible investment opportunities that opportunistic folks could jump on. Right now, I don’t really plan on taking any immediate action. While I don’t disagree this is likely a good buying opportunity, I plan on staying the course with my long term investment strategy. Plus, I don’t have any cash to throw into the market at this time since I’m actually in the process of selling a fair amount of my taxable brokerage account to invest in a small business venture.

Even if I didn’t have the small business investment going on right now, I would still wait a bit for some of the smoke to clear. It is a bit too noisy right now and I don’t think anyone has perfect answers as to what will be happening going forward. It will be interesting to see how this will all unfold though, including actions taken by other countries as well as what Scotland will do.

As we both know Brexit was a shock to the market as it priced in a Bremain scenario, wish I sold some of my bank stocks that day but hey we don’t see the future.

I enjoyed reading your article and think you made a lot of points that the panicked person may not see.

On the investment side I know that several British companies, especially the oil companies, are expected to post strong earnings and it will help with their dividends due to the plunge in the Sterling. Likewise, many other companies may have favorable tailwind effects from Brexit due to the reduction in the currency. Personally, I have been purchasing financials as they have been hit hard as well as health-care in the last few days as many were near their 52-week low, GILD for example. I also read somewhere that the automobile sector is expected to benefit from this event but can’t remember the details right now.

Here are some additional effects that you can consider:

~ The drop in the pound will allow foreigners who wanted to visit England but considered it expensive the opportunity to now visit due to the currency devaluation. Personally, I would take advantage of this situation if I had the money as England just got 10% cheaper over night.

~ Secondly, and you stated this in your article, I suspect that the UK will have favorable agreements with the rest of the EU as they rely on each other. I do not think they will be heavily penalized and it will be a short-term affect on their economy.

~ Lastly, small business are expected to flourish once the restrains of the EU are lifted. The EU is highly regulated which can make production very costly for smaller business which in turn drives down their profits and makes it harder for them to operate. If some of these regulations are relaxed by England I suspect their output would increase, thus increasing employment, and in turn helping England prosper in the long run.

I like how you detailed the situation and proposed some actionable item to invest on. The UK ETF does indeed look a good option and the yield will probably increase as the prices drop. Buy the dip?

Probably a good idea, but I am not sure I would buy the UK dip itself. Between the decrease in stock prices and the decrease in the currency, unless you can invest in local currency or hedge it, that’s a little too tricky for me. My feeling about Brexit is that it won’t actually happen.

Already Scotland and Northern Ireland are interested in leaving the UK to stay with the EU and the Leave camp has been backtracking on their promises and saying that they want informal talks. As The Economist put it, it’s like a dog barking and chasing a car, who accidentally actually catches it. It never intended to and know doesn’t know what to do next.

How I have taken advantage of all this chaos so far this year is by holding US bonds (mostly treasuries) and on that front, Brexit has been great.

As far as international exposure, I feel fortunate in that I reduced my allocation from about 35% down to 10% a month or so ago. It’s actually even less because I have also been moving money into real estate that’s no longer included in the portfolio allocation.

And even though we have seen some recovery, I am still not comfortable. I think (and have written about it on my site) that we are in for a rough ride. That’s why I have been reallocating away from the markets.

Thanks again for putting together a high quality information resource.